How Mortgage Interest Rates Affect Property Values


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It is only logical to believe that a fall in mortgage rates would lead to a rise in the prices of homes, and vice versa. Because it is logical does not mean it is true. In fact, the prices of houses have little or no correlation with mortgage rates, at least, in the short-run.

One of the reasons people assume that home prices are affected by the mortgage rate is because it is a long-term investment, so the value of the asset is the summation of the future benefits or cash flow, discounted by the rate of interest. And a high interest should lead to a reduction in the present value of the future benefits. Another way to look at this claim is that high interest rates should reduce the number of people who qualify for mortgages and even those who qualify would prefer not to pay higher amounts.

One may ask how logic described above could be wrong, as everything about it seems to make sense. History has shown that when the mortgage rate rises, it is followed by a rise in the price of homes. Accordingly, home prices fell about the same time mortgage rates fell.

Rates of interests for long-term assets like bonds and mortgages are majorly determined by expectations of inflation and economic growth–a combination that sets the demand and supply for credit. The increased purchase of houses usually drives the mortgage rates up. What determines the movement of residential real estate prices is the demand for housing, even when the mortgage rates are high. So, the price of houses is based on the strength of the economy. This simply means that prices are almost independent of the rate of mortgages, although one cannot totally ignore the significant effect of mortgage rates on the price of homes.

If history is anything to go by, a mortgage rate is the last thing to be considered when you are looking for an affordable home. As mentioned above, your will and purchasing strength combined with the demand from the economy at large affects real estate prices, and the next time you are in search of a cheap home, you might want to consider those factors.

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